The largest workers' compensation insurer in the world, the State Compensation Insurance Fund of California, does not appear on many published insurer lists. If it did, SCIF and its cousins in New York, Ohio and Washington would be among the top 10 workers' comp insurers in the nation.
These are all state government-sponsored insurers. Today, most state-sponsored insurers are profitable. A few have begun to cultivate regional or even national roles. Their combined market share of workers' comp insurance has quite possibly never been higher, to the detriment of private insurers.
But what is the public benefit of a state workers' comp fund? Can they even be considered a public benefit at all?
Private sector markets for workers' comp insurance are usually highly competitive, and state governments often know little about running insurance ventures.
So, are state funds an example of bad public policy that was either wrong from the start or terribly outdated at the very least?
It's not that simple. Private insurers have endorsed intrusive public interventions in workers' comp markets, particularly in the area of medical price controls.
In addition, there are plenty of successful workers' comp insurance funds. Take, for example, the funds operating in Maine, Hawaii, Louisiana and Texas.
But one line can be firmly drawn. It is this: State-sponsored insurers should respect basic rules of corporate accountability. These include financial disclosure, use of independent auditors, inspection by independent rating agencies, and a candid explanation of public necessity. This kind of discipline will toughen the tenuous grasp of the leading stakeholders, namely the tax-paying public.
Ignoring corporate accountability invites the abuse of stakeholders' interests. The greater hazard for the public is not state fund insolvency, but the chronic mishandling of the state economy's work injury risks, which could cost far more.
The behavior of SCIF in the last few years provides many clues about how loose the reins of accountability can be.
SCIF'S WARNING BELL
California's workers' comp costs have for some time been relatively high. Starting in the late '90s claims costs grew like a virus. Premium costs soared to more than twice that of most other states. Yet, despite a time of viral-like inflation in the cost of claims, the fund nevertheless grew by 600 percent. Within a few years, it had taken control of half the value of all workers' comp insurance written in the state.
How was it at all possible? In 2001, SCIF began to sell aggressively. It grew. As the fund grew, its pricing model was designed in such a way that its surplus could not grow at a commensurate pace. Prices were too low to allow the fund's surplus to keep up.
As a result, the fund grew top-line revenue primarily. By 2002, however, the fund had reached a point where just one bad year, or a few mediocre years, would have wiped out its surplus.
The ratings agencies, however, had already taken notice. A.M. Best & Co., which had assigned SCIF a rating of A- in 1997, lowered its rating to B+ in May 2000. In March 2002, the agency further punished the fund with a B- rating. In April 2002, SCIF decided no longer to be rated by A.M. Best.
Similarly, in 2001, SCIF took a beating from the other big ratings agency, Standard and Poor's, which downgraded the fund from A to BB+. SCIF responded by terminating its relationship with the agency.
When Dianne Oki, the former president of SCIF, wrote in the 2002 annual report that the "State Fund has become a model for the industry and other states," she did not disclose the downgrades or the fund's refusal to be rated.
Yet she discussed a dispute with the outside auditor, a quarrel which ultimately resulted in the auditor's termination. Oki, who resigned Feb. 4, 2005, after just two years, described the fund as a nonprofit, public enterprise fund that operated "like a mutual insurance carrier."
If SCIF had actually behaved as a mutual insurance carrier, California insurance regulators would most likely have seized the company and dismissed its top executives. Employers would likely have sought to abandon SCIF on the advice of brokers. But since SCIF also served at the insurer of last resort, with private insurers exiting the market or failing, employers were held hostage, as they had no place else to go.
In the space of a few years, SCIF had fired its rating agencies, dismissed its auditors, and sued California insurance regulators--all the while describing itself as a financially solid, model insurer. SCIF remains a member of the American Association of State Compensation Insurance Funds. As an insurer, required by law to be self-sustaining and eschew state subsidies, SCIF would have failed some time between 2001 and 2003.
Sacramento politicians, however, were not going to let SCIF fail. By the time of legislative reforms in 2004, premiums had already soared to about $15 billion. This was three times the national average and twice that of the next highest-cost state, Vermont. Employers in California paid at least $10 billion more in premiums due to the delay.
Yet, SCIF could have acted with greater restraint by pricing its policies to allow for an appropriate increase in surplus. Had SCIF done so, and had it been more forthcoming in its financial disclosures, legislative reforms may well have taken place in 2002 or 2003, at the latest.
It is safe to assume that over several years, employers paid at least half more than they would have if reforms had been implemented more quickly.
SCIF's behavior is a bell tolling for all states. Any venture calling itself a state fund is implicitly drawing upon public faith, if not actual public credit. The threat to private insurers is an uneven playing field. The threat to the public is excessive injury and disability resulting from the underpricing of policies and the mishandling of claims.
At the very least, state funds should adhere to the same financial standards of private insurers. They should demonstrate how they are uniquely solving work injury risks.
Executive teams in some state funds are demonstrably self-disciplined, expert in risk, committed to deepening their state's mastery of injury risk, and aghast at the behavior of SCIF.
Historically, state workers' comp funds are insurers that began life under a unique grant of state sponsorship and continue, as much as 90 years later, as instruments of public policy. The golden moment for a state-sponsored insurer, or state fund, comes when the private market for insurance breaks down and a state-sponsored remedy is called for.
EVALUATING STATE FUNDS
We can evaluate state-sponsored funds in two ways. One is to measure their public benefit. Is a state-sponsored risk-bearing entity a valid model for improving the performance of a workers' comp system? The other is to measure the accountability of such risk-bearing vehicles. Are managers of such funds accountable to anyone?
Proponents of state funds say they exist--indeed they must exist--to rebalance a permanent crisis or dislocation in the marketplace for insurance. But after listening to this message for years, it's become clear that no such permanent crisis exists.
Maybe the public interest could be tied more narrowly to violent cycles or event disruptions in the market. Extreme swings in the cycle, ruinous price discounting overcompensated by huge price increases and market exits, occurred in the four-year period from 1989 to 1993, and again from 2000 to 2003. State funds could sound alarms about worsening claims trends and lead the market faster back to stability.
Private insurers have a problem rejecting this argument completely, as they use a similar argument to lobby for the extension of the tax-backed Terrorism Risk Insurance Act.
Sometimes a government-sponsored risk-bearing program may be the easiest way to calm high anxiety in the market. But state funds created for this purpose at some time outlive their initial reason for being.
State lawmakers often address dislocations in the insurance marketplace through the use of assigned-risk pools or residual markets. Every state has a mechanism in which to place otherwise unacceptable workers' comp risks. Some state funds serve this function, but private carriers could do it as well.
A dramatic example of an assigned-risk pool success story is in Massachusetts, a state without a state fund.The state enjoyed the greatest relative decline in workers' comp insurance costs of all states in the past 15 years. It restored its market to health, in part by launching the assigned-risk pool, a massive incentive program for employers.
Aside from the arguments about whether the existence of state funds are justified by the occurrence of a permanent or temporary crisis, there is an argument to be made that such funds can influence injury risk at greater depth and breadth than can most private insurers. The worker and the household, the employer and the trade association, the doctor and the medical community all influence injury risk.
State funds, thanks to their wall-to-wall focus within a single state, aided often by large market share, are better placed than private insurers to penetrate deeply into all industry segments and influence injury risk.
Examples include Arizona's contracts with 60 business associations to provide safety and other training services to its customers, Rhode Island's partnership with Blue Cross, and Ohio's network of competing managed care organizations.
The problem is that few funds use their clout and focus to master injury risk. Nor am I aware of any fund that measures occupational medical clinics, for instance, or sets targets for injury frequency and severity, or studies the in-state economy to any depth. If they cannot define and defend their public benefit, why are they with us?
PETER ROUSMANIERE, a Vermont-based consultant and writer, is a regular columnist for Risk & Insurance®. He can be reached at firstname.lastname@example.org.
April 1, 2005
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